The Economy of Central America According to Fitch

q24N – Fitch notes that the relatively favorable external environment will not be enough for Central American countries to improve their credit ratings, which could remain stable despite fiscal problems.

Fitch Ratings-New York-22 October 2015: External tailwinds are unlikely to lead to a significant uplift in Central America’s creditworthiness, says Fitch Ratings in a new special report. While external finances and inflation across the region have benefited from the U.S. recovery and lower oil prices, the outlook for growth, public finances and structural issues is more mixed. Nonetheless, the new external backdrop could be a stabilizing factor in credit trends in the region, especially given the negative bias of ratings in recent years. Currently, only one country (Costa Rica) has a Negative Outlook.

After a decade-long commodity boom that benefited Latin America’s commodity exporters, low oil prices and stronger U.S. growth are now creating a more positive environment for oil importers in Central America and the Dominican Republic. As a result, Fitch expects regional growth of 4.3% in 2015-2017 to significantly outperform the Latin American average of 0.7% during that period.

These tailwinds should support the dynamic economies of Panama and the Dominican Republic, although some growth moderation is expected on cooling domestic investment, while Costa Rica’s economy is slowing on the closure of Intel’s microchip plant. El Salvador and Guatemala could sustain higher growth rates than seen in the past decade, although structural bottlenecks from crime and human capital continue to restrain growth potential.

‘Economic recovery in the U.S. could generate positive spillovers for the region due to strong linkages in terms of remittances, exports, tourism and foreign direct investment,’ said Shelly Shetty, Head of Fitch’s Latin America sovereign team. ‘How countries use the tailwinds to re-build buffers and policy space and improve competitiveness through reforms will be key for credit trends in the region,’ added Shetty.

However, the Fed liftoff could tighten financing conditions and increase currency volatility. The greater reliance of sovereigns and banks on external funding has increased the sensitivity to adverse changes in external financing conditions in El Salvador and Costa Rica. The Dominican Republic could face challenges in the context of limited exchange rate flexibility given its weak external liquidity position.

Lower oil prices are expected to narrow regional current account deficits to 3.2% in 2015-2017, from 5.2% in 2012-2014, and to reduce inflation to 2.1% from 3.8%. Cheaper energy could also support consumption and investment by boosting the disposable income of households and reducing production costs for firms, but the impact will depend on different degrees of pass-through to consumer prices and diversification of energy matrices.

The fiscal impact of cheaper oil will be mixed due to varying energy subsidy and fuel tax schemes. Fitch projects deficits to be stable at an average 3.4% in 2015-2017 and debt to rise moderately in most countries during the same period. ‘Energy subsidy savings in Panama and the Dominican Republic are creating fiscal space, although this may mostly be use to accommodate other spending plans rather than for deficit reduction’ said Todd Martinez, Associate Director in Fitch’s sovereign team. ‘High deficits in Costa Rica and El Salvador could persist absent structural reforms,’ added Martinez.

A favorable external context for the region could improve conditions for advancing reforms, reversing the deterioration in credit metrics, but politics could get in the way. Fiscal reforms in Costa Rica and pension reform in El Salvador could face legislative hurdles, as could institutional reforms to electoral and public contracting laws in Guatemala and Panama. The Dominican government’s legislative majority and broad popular support could favor reform momentum after the May 2016 election.

Source: Centralamericandata.com

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